16 April 1964
Supreme Court


Case number: Appeal (civil) 250 of 1963






DATE OF JUDGMENT: 16/04/1964


CITATION:  1964 AIR 1843            1964 SCR  (7) 776  CITATOR INFO :  R          1969 SC1053  (7)  RF         1984 SC1733  (9)  MV         1986 SC 757  (10,15)  RF         1991 SC1338  (14,15)

ACT: Income-tax-Trading   adventure-Profits  of   business   Com- putation-Value  of stock-in-trade-Inclusion of Value at  the end  of  year  of  account-Necessity-Assessee’s  method   of accountancy-Powers   in  Income-tax  Officer  in   computing profits-Indian  Income-tax  Act,  1922 (11 of  1922)  s.  13 proviso.

HEADNOTE: The   assessee   firm  acquired  for  Rs.   1,00,000/-   the exploitation  rights of a cinematograph film which  were  to enure for four years.  For the period, December 25, 1947  to August 2, 1948, which was the previous year corresponding to the  assessment  year  1949-50 the firm  filed  a  voluntary return  declaring  that  Rs. 28,643/-  were  earned  by  the exploitation of the film.  In the statement submitted by the firm  the total receipts credited in the firm’s  books  were Rs.  1,46,849/-  and against that amount  were  debited  Rs. 18,206/-  as  expenditure and Rs. 1,00,000/- as  the  amount disbursed  for  acquiring  the  exploitation  rights.    The Income-tax  Officer was of the view that from the  statement of  account  which omitted to include at the  close  of  the account  year  the value of the right in the  film  for  the unexpired period, the profits of the firm could not properly be  deduced.   Accordingly, he estimated the  value  of  the rights for the unexpired period of exploitation to which the firm  was  entitled on August 2, 1948, at Rs.  65,000/-  and computed the net profits of the firm as an unregistered firm at  Rs.  93,642/-  and  assessed  income-tax  and  super-tax payable  by the firm on that footing.  In the appeals  filed against the order or assessment, only the correctness of the estimated value of the rights of the film at Rs. 65,000/-was challenged, and the Appellate Tribunal reduced the valuation to  Rs.  40,000/-.  On reference, the High Court  of  Madras took the view that it was the cash system that the  assessee had adopted. that valuation of the closing stock was not  an



incident  of  that system for ascertaining the  profits  and that the Incometax Officer had no power under the proviso to s.  13  of  the  Indian Income-tax Act,  1922,  to  force  a different  system  on  the assessee  either  the  mercantile system or a hybrid system of cash plus valuation of  closing stock. Held:     In  a  trading  venture, for  computing  the  true profits  of the year, the stock-in-trade must be taken  into account,  whatever method of book-keeping was  adopted;  and the  High  Court was in error in holding  that  because  the assessee  had maintained his accounts in the cash system  it was not open to the Incometax Officer to add to the receipts from the business the value of the stock-in-trade at the end of the year for the purpose of properly deducing the profits of the business for the year in question. There  was  not  warrant in the case of  assuming  that  the income-tax   Officer  sought  to  displace  the  method   of accountancy  adopted  by  the  assessee  it  -"-as  only  by applying the proviso to s. 13 of the Indian Income-tax  Act, 1922, that the Income-tax Officer made the computation  upon the basis and in the manner in which in his opinion  profits could be properly deduced. 777

JUDGMENT: CIVIL APPEALLATE JURISDICTION: Civil Appeal No. 250 of 1963. Appeal  by special leave from the judgment and ,order  dated February  2, 1960 of the Madras High Court in Case  Referred No. 1 of 1955. R.   Ganapathy Iyer and R. N. Sachthey, for the appellant. S.   Narayanaswamy  and  R. Gopalakrishnan,  for  respondent nos.  I and 3-6. April 16, 1964.  The Judgment of the Court was delivered by. SHAH,  J.-Respondents to this appeal are a firm  constituted under  a deed dated December 12, 1947.  The firm  originally consisted  of  three partners: K. N. Damodara  Mudaliar,  A. Krishnaswami  Mudaliar  and v.  Thangaraja  Mudaliar.   K.N. Damodara  Mudaliar acquired for the firm for Rs.  1,00,000/- the exploitation rights which were to ensure for four  years in a cinematograph film "Apoorva Chinthamani" for the  North Arcot, the South Arcot and the Chingleput districts and  for Pondicherry.   For the period, December 25, 1.947 to  August 2, 1948--which was "the previous year" corresponding to  the assessment  year  1949-50the firm filed a  voluntary  return declaring that Rs. 28,643/were earned by the exploitation of the film.  In the statement submitted by the firm the  total receipts  credited in the firm’s books were Rs.  1,46,849/-, and  against  that  amount  were  debited  Rs.  13,206/-  as expenses  and  Rs. 1,00,000/- as the  amount  disbursed  for acquiring   the   exploitation  rights.   Thereby   in   the computation of the profits of the business, the firm debited the amount paid for acquiring the rights of exploitation  of the  film,  but  did not take credit for the  value  of  the unexpired  exploitation rights at the end of  the  "previous year".   On  August 15, 1948, a deed of dissolution  of  the partnership  was executed, and Damodara Mudaliar  sold  with effect from August 6, 1948, his half interest in the  assets of the partnership to Krishnaswami Mudaliar for Rs.  2,000/- and  retired  from the partnership.  On August  27,  1948  a trial  balance-sheet  of  the firm’s books  of  account  was prepared  showing  a cash balance of Rs. 190/12/4,  a  debit against Krishnaswami Mudatiar for Rs. 2.641/8/8 and  credits in  favour  of  Damodara Mudaliar  and  Thangaraja  Mudaliar



respectively for Rs. 1,888/2/11 and Rs. 944/2/1.  Thereafter Krishnaswami  Mudaliar,  Thangaraja  Muidaliar  and  V.   S. Lakshmanan  (an  outsider) formed  themselves  into  another partnership  to exploit the film for the  unexpired  period. From  this  partnership  Krishnaswami  Mudaliar  retired  on February 22. 1949 agreeing to receive Rs. 12000/- for his 778 six sixteenth share in the assets of the firm on the date of retirement. In the assessment of the respondent firm for the year  1949- 50  the  Second  Additional’  income-tax  Officer,   Vellore declined  to accept the statement of account that  the  firm had  earned  till August 2, 1948, a net profit of  only  Rs. 28,643/- as truly representing the profits of the firm.  Fie observed  that "no stock valuation of the picture  has  been taken but only the excess collection over purchase value has been returned", indicating thereby that in his view from the statement  of account which omitted to include at the  close of  the  year the value of the rights in the  film  for  the unexpired period the profits of the firm could not  properly be  deduced.  The Income-tax Officer estimated the value  of the rights for the unexpired period of exploitation to which the firm was entitled on August 2, 1948 at Rs. 65,000,-  and computed net profits of the firm as an unregistered firm  at Rs. 93,642/and assessed income-tax and super-tax payable  by the firm on that footing. In  appeal  by  the firm to  the  Appellate  Assistant  Com- missioner, the correctness of the estimated value of the ex- ploitation rights of the film at Rs. 65,000/ was alone chal- lenged and it was submitted that the sum of Rs. 4,000/-  was the  true  value of the assets at the end  of  the  previous year.    Damodara  Mudaliar  the  retiring  partner   having relinquished  his  rights representing half  share  for  Rs. 2.000/- only.  The Appellate Assistant Commissioner rejected the   contention,   holding  that  the  valuation   of   the exploitation rights for the unexpired period in the deed  of dissolution  dated August 15, 1948 was "dictated  by  extra- commercial  considerations". and confirmed the valuation  of Rs. 65,000/- made by the Incometax Officer.  Even in  appeal to the Income-tax Appellate Tribunal, Madras, the respondent firm merely contended that the valuation of the exploitation rights for the unexpired period was excessive.  The Tribunal partially upheld the plea, and reduced the valuation to  Rs. 40.000/- as on August 2, 1948, and directed modification  of the assessment on that footing. Pursuant to an order issued by the High Court of Madras in a petition  under  s. 66(2) the Tribunal stated the  case  and referred the following question: ---               "Whether  on  the facts and  circumstances  of               this  case  the  Tribunal  was  justified   in               applying  the proviso to s. 13 of the  Income-               tax Act and in confirming the assessment on  a               mercantile basis of accounting." 779 The  High  Court held that it was open to  the  assessee  to maintain  accounts according to a recognised system  of  ac- counting and the assessee having adopted the cash system  of ,accounting, and the Tribunal having assigned no reasons for discarding that system in the computation of the profits the Tribunal was in error in making the assessment on the  basis of the mercantile system of accounting.               The High Court observed:-               "When  we reach the position that it  was  the               cash  system that the assessee had adopted  in               this  case, and that valuation of the  closing



             stock  was not an incident of that system  for               ascertaining the profits, it should be obvious               that the Income-tax Officer had no power under               the  proviso  to s. 13 to  force  a  different               system ’on the assessee either the  mercantile               system  or  a  hybrid  system  of  cash   plus               valuation of closing stock." The High Court accordingly answered the question referred in the negative.  Against the order, with special, leave,  this appeal is preferred. The  question to be determined in this appeal is whether  in the  computation  of the income of the firm under  the  head "Profits  and gains of business" the Income-tax Officer  was bound  by  the  method of accounting in which  the  cost  of acquisition  of  the film of which the  exploitation  rights were  held was debited at the commencement of the year,  but the  value of the film at the end of the year  was  ignored. Section 10 of the Indian Income-tax Act, 1922, provides that tax -shall be payable by an assessee under the head "Profits and gains of business, profession or vocation" in respect of the profits or gains of any business, profession or vocation carried  on  by  him.   Such profits or  gains  have  to  be computed -after making the allowances set out in sub-s. (2). Section 13 provides that the income, profits and gains shall be  computed,  for  the  purposes  of  ss.  10  and  12,  in accordance with the method ’of accounting regularly employed by  the assessee, provided that, if no method of  accounting has  been  regularly employed or if the method  employed  is such  that,  in the opinion of the Income-tax  Officer,  the income,  profits  and  gains  cannot  properly  be   deduced therefrom,  then  the computation shall be  made  upon  such basis  and  in  such manner as the  Income-tax  Officer  may determine. It  may be recalled that the Income-tax Officer had  in  the order  of assessment observed that the firm had not  made  a stock valuation of the film and had merely taken the  excess collection over the purchase value and had submitted its 780 return  of income ’on that basis.  No express order was  re. corded by the Income-tax Officer that in his opinion the in- come, profits or gains of the business could not properly be deduced from the method of accounting employed by the  firm, but  it  is implicit in what is stated by him  that  without valuation  of the unexpired exploitation rights the  profits of  the  year of account could not be computed.   With  this view.  it  appears,  the  Appellate  Assistant  Commissioner agreed. In appeal to the Appellate Tribunal the only plea raised was that  the  Income-tax Officer had erred  in  estimating  the value of the unexpired exploitation rights at Rs.  65,000/-. That  was partially accepted, and the value was  reduced  to Rs.  40,000/-.   It  is  difficult  to  appreciate  how  any question  about  the regularity of the  proceedings  of  the Income-tax Officer by the adoption of the mercantile  system of accounting and by the application of the proviso to s. 13 of  the Incometax Act arose from the order of the  Tribunal. The  High Court has under the Income-tax Act power  to  call upon  the  Appellate Tribunal to state a case’ only  if  the High  Court  is not satisfied about the correctness  of  the decision of the Tribunal that no question of law arises from the  order  of them Tribunal.  The grounds of  appeal  filed before  the  Tribunal  and before  the  Appellate  Assistant Commissioner  make it abundantly clear that the question  as to the applicability of the proviso to s. 13 to the  profits disclosed by the respondent firm was never challenged.   Nor



can  it be said that the Tribunal "forced the x x x firm  to adopt  for  the  purpose  of  computation  of  its  profits" a  .system of accounting other than the one adopted  by  the firm.   In the title of the order by the Income-tax  Officer it was recited that the, method of accounting adopted by the firm  was "mercantile", but that does not amount  to  saying that he proposed to compute the income on the basis that the accounts should be re-written on the mercantile system. The  question referred to the High Court asks for advice  on the  justification  for applying the proviso to s.  13,  and computation  of the income on the basis of  the  mercantile, system  of  accounting.  On neither of  these  two  branches there was any argument raised by the firm before the  Tribu- nal.  But we do not propose to dispose of this appeal on the limited ground that the question as framed did not arise out of the order of the Tribunal and need not be answered.   The grounds given by the High Court in support of their  answer, to the question referred raise a matter of principle of some importance  in  the  computation of income  of  an  assessee carrying  on  a trading venture with the aid  of  a  wasting asset,  and  we have heard elaborate arguments  advanced  by counsel at the Bar and we deem it necessary, to express  our opinion on the questions debated. 781 It is true that the Revenue authorities and the Tribunal did take  into consideration the stock valuation at the  end  of the year of account, but that was not because in their  view the  system of accounting adopted was or should  be  mercan- tile: the truth of the matter is that in their view, profits of  the firm for the year could not, having- regard  to  the nature  of  the  business,  properly  be  deduced  from  the accounts,  "unless  the  opening  and  closing  stocks  were brought  into  the  picture".  This is  made  clear  by  the observations   of  the  Tribunal  in  paragraph-15  of   the statement of the case:               "x  x x in all trading cases the true  profits               cannot   be   deduced  from  any   system   of               maintaining    accounts   whether   cash    or               mercantile,  unless  the opening  and  closing               stocks are brought into the picture at cost or               market  price whichever is lower; it will  not               avail  an  assessee to say that  in  his  cash               system, he had not made any profit on his cash               sales  till  all  his stock  is  disposed  of.               Income-tax  is an annual levy and the  profits               of  each  year require to be  ascertained  for               that  purpose as accurately  as  circumstances               permit.   It  therefore,  in  any  system   of               accounting   maintained   by   the   assessee,               otherwise acceptable, the stocks are left  out               of  account,  the  aforesaid  proviso,  it  is               humbly   submitted,  necessarily  has  to   be               invoked, even if it were for the sole  purpose               of  adjusting the book figures for  the  stock               figures." Correctness  of  this view especially in the  context  of  a trading venture by the exploitation of a wasting asset,  but which   is  the  assessee’s  stock-in-trade,  falls  to   be considered. Section 13 of the Indian Income-tax Act was incorporated for the first time in the Income-tax legislation in India by the Income--tax Act II of 1922, because in a case decide’  under the  Income-tax  Act, 1918, Wallis, C. J.,,  delivering  the principal judgment of the Full Bench in Secretary, Board  of Revenue,  Madras  v. Arunachalam Chettiar(1)  expressed  the



view  that whatever may be the system of accounting  adopted by  an assessee, income assessable to tax means  the  income actually  or constructively received and that the  words  of the  charging  section  placed limits  upon  the  succeeding sections  specifying the different classes of income  liable to  tax.   To  supersede  this exposition  of  the  law  the Legislature while enacting Act 11 of 1922 found it necessary to  enact  s. 13. The section leaves it to the  assessee  to adopt  any compute of accounting and obliges the  Income-tax Officer  to  compute the income, profits and gains  for  the purposes of ss. 10 and 782 12  in accordance with such method of  accounting  regularly employed, if profits of the business can properly be deduced therefrom.  The Judicial Committee of the privy Council  ob- served  in Commissioner of Income-tax, Bombay  v.  Sarangpur Cotton Manufacturing Company Ltd, Ahmedabad(2):               " x x x the section relates to a method of ac-               counting  regularly employed by  the  assessee               for his own purposes x x x and does not relate               to a method of making up the statutory  return               for  assessment to income-tax.  Secondly,  the               section  clearly  makes such a method  of  ac-               counting  a compulsory basis  of  computation,               unless,  in  the  opinion  of  the  Income-tax               Officer, the income, profits and gains  cannot               properly be deduced therefrom.  It may well be               that,  although the profit brought out in  the               accounts is not the true figure for income-tax               purposes,  the true figure can  be  accurately               deduced therefrom. The Board also observed:-               "It  is  the duty of the  Income-tax  Officer,               where there is such a method of accounting  to               consider whether the income, profits and gains               can  properly  be deduced  therefrom,  and  to               proceed  according  to his  judgment  on  this               question." Again  as observed by this Court in Commissioner of  Income- tax  v.  Mcmillan  &  Co.(2)  the  expression       "in  the opinion of     the Income-tax Officer" in the proviso to  s. 13  of  the Indian Income-tax Act, 1922, does not  confer  a mere  discretionary  power;  in the  context  it  imposes  a statutory duty on the Income-tax Officer to examine in every case  the method of accounting employed by the assessee  and to see whether or not it has been regularly employed and  to determine  whether  the  income, profits and  gains  of  the assesses could properly be deduced therefrom. But  the section only deals with the computation of  income, profits and gains for the purposes of ss. 10 and 12 and does not  purport to enlarge or restrict the content  of  taxable income,  profit and gains under the Act.  Section  2(15)  of the  Act defines "total income" as meaning total  amount  of in. come, profits and gains referred to in sub-s. (1) of  s. 4 computed in the manner laid down in the Act.  Section 4(1) lays down what income shall be included in the total income, and  ss.  10(2),  12(2), 12B(2), 14, 15A, 15B,  15C  and  16 prescribe  the manner of computation of income, profits  and gains in (1) L.R. 65 I.A. 1. (2)  33 I.T.R. 182.                             783 different  circumstances, and also prescribe special  excep- tions.   Section  13  does not  directly  impinge  upon  the application  of these provisions: it merely prescribes  that



the  computation of taxable profits shall be made  according to  the method of accounting regularly employed.   Where  in the  opinion of the Income-tax Officer the  income,  profits and gains cannot properly be deduced from the method of  ac- counting,  it is open to the Income-tax Officer  to  compute the  income  upon  such  basis in  such  manner  as  he  may determine.   The  section  does not  compel  the  Income-tax Officer  to  accept  a balance-sheet of  cash  receipts  and outgoings  prepared  from the books of account;  he  has  to compute  the  income  in  accordance  with  the  method   of accounting regularly employed by the assessee. The only departure made by s. 13 of the Indian Incometax Act from  the tax legislation in England is that  whereas  under the  English legislation the Commissioner is not obliged  to determine  the profits of a business venture,  according  to the method of accounting adopted by the assessee, under  the Indian  Income-tax Act, prima facie, the Income-tax  Officer has for the purpose of ss. 10 and 12 to compute the  income, profits and gains in accordance with the method of  account- ing  regularly  employed by the  assessee.   If,  therefore, there  is a system of accounting regularly employed  and  by appropriate adjustments from the accounts maintained taxable profits  may properly be deduced, the Income-tax Officer  is bound  to compute the profits in accordance with the  method of  accounting.  But where in the opinion of the  Income-tax Officer  the  profits cannot properly be  deduced  from  the system accounting adopted by the assessee it is open to  him to  adopt a more suitable basis for computation of the  true profits. Among  Indian businessmen, as elsewhere, there  are  current two principal systems of book-keeping There is, firstly, the cash  system  in  which a record  is  maintained  of  actual receipts and actual disbursements, entries being posted when money  or money’s worth as actually received,  collected  or disbursed.   There  is secondly the  mercantile  system,  in which entries are posted in the books of account on the date of  the transaction i.e. on the date on which rights  accrue or  liabilities  are incurred, irrespective of the  date  of payment.   For  example, when goods are sold  on  credit,  a receipt entry is posted as of the date of sale, although  no cash is received immediately in payment of such goods; and a debit entry is similarly posted when a liability is incurred although payment on account of such liability is not made at the time.  There may have to be appropriate variations  when this  system  is  adopted by an assessee who  carries  on  a profession.  Whereas 784 under  the  cash system no account of what  are  called  the outstandings  of the business either at the commencement  or at the close of the year is taken; according to the  mercan- tile  method  actual cash receipts during the year  and  the actual  outlays during the year are treated in the same  way as  under the cash system, but to the balance thus  arising, there is added the amount of the outstandings not  collected at  the  end  of  the year and from  this  is  deducted  the liabilities  incurred or accrued but not discharged  at  the end  of the year.  Both the methods are somewhat rough.   In some cases these methods may not give a clear picture of the true  profits earned and certainly not of  taxable  profits. The  quantum  of allowances permitted to be  deducted  under diverse  heads under s. 10(2) from the income,  profits  and gains  of  a business would differ according to  the  system adopted.   This is made clear by defining in sub-s. (5)  the word "paid" which is used in several clauses of sub-s (2) as meaning actually paid or incurred according to the method of



accounting upon the basis of which the profits or gains  are computed  under  s.  10.  Again where  the  cash  system  as adopted,  there is no question of bad debts or  outstandings at  all: in the case of mercantile system against  the  book profits  some of the bad debts may have to be set  off  when they  are  found  to be mercantile  system,  there  are  in- numerable  other systems of accounting which may  be  called hybrid or heterogeneous-in which certain elements and  inci- dents of the cash and mercantile systems are combined. But whatever method of book-keeping is adopted, in the  case of a trading venture, for computing the true profits of  the year the stock-in-trade must be taken into account.  If  the value  of stock-in-trade is not taken into account,  in  the ultimate result the profit or loss resulting from trading is bound  to  get absorbed or reflected in  the  stock-in-trade unless the value of the stock-in-trade remains unchanged  at the  commencement of the year and at the end of the  year.It must be remembered that under the Income-tax Act, tax   is levied  on income, profits and gains, and not  on  receipts: taxable profits therefore cannot ordinarily be deduced  from cash receipts alone.  If in the computation of profits of  a trading  venture, only the cash receipts and  outgoings  are taken into account, in substance emergence of profits  would be  deferred, till the firm’s capital outlay  is  completely recouped, thereby transforming what in truth are profits  of the business into capital, by book-keeping entries. In  this  case  it is unnecessary to  consider  whether  the method  of accounting adopted of ignoring the value  of  the stock-in-trade may be regarded as regularly employed by  the respondent  firm, when it is the first year of account.   It is com- 785 mon ground that the method of accounting was not mercantile. but  was wholly or primarily cash.  The  Income-tax  Officer was  of the view that in the absence of  stock-valuation  of the  film which was a wasting asset of the  partnership  and which  was exploited for earning profits, the income of  the firm  could not properly be deduced and with that  view  the Appellate  Assistant  Commissioner  and  the  Tribunal  have agreed.  The High Court, however, held that the  maintenance of  account  on  cash basis being  a  recognised  method  of accounting,  the Income-tax Officer was bound by the  choice of  the assessee who had adopted that system of  accounting, and  to compute the income in accordance with  that  method, unless  the  Income-tax  Officer  was  satisfied  that   the assessee  had not regularly adopted that system.   The  High Court also observed that what the Department had done was to make  the  assessment  on  the  basis  that  the  system  of accounting  adopted by the assessee was mercantile-a  system which  the assessee had never adopted, and thereby  computed the  profits of the assessee, by taking  into  consideration valuation of the closing stock which was not an incident  of the cash system.  The Income-tax Officer had in the view  of the High Court no power under the proviso to s. 13 "to force a  different  system on the assessee either  the  mercantile system or a hybrid system of cash plus valuation of  closing stock". In  coming  to that conclusion, in our  judgment,  the  High Court  erred.  Note the facts: an amount of  Rs.  1,00,000/- was  paid by the firm for acquiring a wasting  asset,  which was to be exploited for the benefit of the partnership.  The price  paid  for  acquiring  the asset  was  debited  as  an outgoing.   At  the  end  of the year  there  was  a  total, collection  of  Rs. 1,46,849/- by the  exploitation  of  the asset.   The expenses for carrying on the business  amounted



to  Rs. 18,206 / -. The result according to  the  respondent firm was a net profit of Rs. 28,647/-.  This was arrived  at by posting the outgoing for acquiring its stock-in-trade  as a proper debit, and ignoring the value of that asset at  the end  of the year altogether.  Under the Income-tax  Act  for the purpose of the assessment each year is a  self-contained unit, and if out of the receipts the cost of the film was to be  deducted in the absence of an entry crediting the  value of  the  asset at the end of the year, for arriving  at  the income  of  the profit of the firm would  either  wholly  or substantially be absorbed in the amortization of the capital value  of  the asset.  The result of  the  accounting  would therefore  give a false picture of the partnership,  however lucrative  the business may in reality be.  The  methods  of computation  of  taxable incomes prescribed by  the  Act  of different kinds of income are undoubtedly highly artificial, but the Act does not compel the Income-tax Officer to accept a  statement of account which is not prepared  according  to any recognised accounting practice. 786 In  Commissioner of Inland Revenue v. Cock Bussell  and  Co. Ltd.(1).  Croom-Johnson  J., in dealing with  valuation  of’ stock-in-trade for purposes of taxation observed:               there  is  no word in the  statutes  or  rules               which  deals.  with this question  of  valuing               stock-in-trade.   There  is  nothing  in   the               relevant  legislation which indicates that  in               computing   the   profits  and  gains   of   a               commercial  concern the stock-in-trade at  the               start of the accounting period should be taken               in  and that the amount of the  stock-in-trade               at the end of the period should also be  taken               in.   It would be fantastic not to do  it:  it               would  be  utterly  impossible  accurately  to               assess profits and gains merely on a statement               of  receipts and payments or on the  basis  of               turnover.   It has long been  recognised  that               the  right  method of  assessing  profits  and               gains  is to, take into account the  value  of               the  stock-in-trade at the beginning  and  the               value of the stock-in-trade at the end as  two               of  the items in the computation.  I need  not               cite  authority for the  general  proposition,               which  is  admitted at the Bar, that  for  the               purposes of ascertaining profits and gains the               ordinary  principles of commercial  accounting               should  be  applied, so long as  they  do  not               conflict  with  any express provision  of  the               relevant statutes ." We  have already said that in England there is no  provision which compels the tax officer to adopt in the computation of income  the system of accounting regularly employed  by  the assessee.  But whatever may be the system-whether it is cash or  mercantile-as observed by Croom-Johnson J.-in a  trading venture it would be impossible accurately to assess the true profits  without taking into account the value of the  stock in  trade  at  the beginning and at the  end  of  the  year. Reference  may  also  be  made to  Whimster  &  Co.  v.  The Commissioner  of Inland Revenue(2) in which  Lord  President Clyde observed at p. 823:-               "In computing the balance of profits and gains               for  the  purposes of Income Tax, x  x  x  two               general  and  fundamental  commonplaces   have               always  to  be  kept in mind.   In  the  first               place,  the profits of any particular year  or



             accounting period must be taken to consist  of               the  difference between the receipts from  the               trade   or  business  during  such   year   or               accounting period and the expenditure laid out               to earn those receipts.  In the second  place,               the               (1) 29 T.C. 387.    (2) T.C. 813.               787               account  of profit and loss to be made up  for               the  purpose of ascertaining  that  difference               must be framed consistently with the  ordinary               principles of commercial accounting, so far as               applicable,  and in conformity with the  rules               of  the  Income-tax  Act, or of  that  Act  as               modified by the provisions-’ and schedules  of               the Acts regulating Excess Profits Duty as the               case   may  be.   For  example  the   ordinary               principles  of commercial  accounting  require               that   in  the  profit  and  loss  account   a               merchant’s  or  manufacturer’s  business   the               values  of the stock-intrade at the  beginning               and  at the end of the period covered  by               the  account  should  be entered  at  cost  or               market price, whichever is the lower. although               there  is  nothing about this  in  the  taxing               statutes." Similarly  in Commissioner of Income-tax and Excess  Profits Tax, Madras v. Messrs.  Chari and Ram, Madura(1)  Rajamannar C.J.,  observed that stock-in-trade in hand is an  essential item in the computation of the profits for a period. "Profits"  as  observed by Fletcher-Moulton,  L.J.,  in  the Spanish Prospecting Company Ltd. in re.(2).               "implies  a comparison between the state of  a               business   at  two  specific   dates   usually               separated  by  an  interval of  a  year.   The               fundamental  meaning  is the amount  of  gains               made  by the business during the  year.   This               can only be ascertained by a comparison of the               assets of the business at the two dates.               "We  start  therefore  with  this  fundamental               definition  of profits, namely, if  the  total               assets  of  the business at the two  dates  be               compared, the increase which they show at  the               later date as compared with the earlier date x               x x x represents in strictness the profits               of   the   business  during  the   period   in               question." It  is true that in that case Fletcher-Moulton,  L.J.,  made the  observations  not  in dealing with a  profit  and  loss account in a case relating to taxation, but with a, balance- sheet  of  a company intended to show the  actual  financial condition  of  a  business  at  the  end  of  a  year.   The observations  however do show that in  ascertaining  profits what may be regarded as normal book-keeping practice has  to be  observed.   Whether in the case of  trading  in  special classes  of  assets appropriate adjustments may have  to  be made it beside the point. The  Income-tax  Act makes no provision with regard  to  the valuation  of  stock.   It charges for payment  of  tax  the income, (1) 17 I.T.R. 1.                (2) [1911]  1 Ch. 92. 788 profits  and gains which have to be computed in  the  manner provided  by the Income-tax Act.  In the case of  a  trading venture  these profits have to be adjusted in the  light  of



the  provisions of the Income tax Act permitting  allowances prescribed thereby.  For that purpose it is the duty of  the Income-tax   Officer to find out what profits  the  business has  made  according to true Accountancy practise ,  in  the system adopted, and thereafter to make requiste adjustments, and even appropriate modifications on the rule suggested  by Fletcher-Moulton, L.J. to ascertain the taxable profits.  it is true as observed by Lord Buckmaster in The Naval Colliery Co.  Ltd. v. The Commissioner of Inland Revenue(1) that  the principle of determining the profits of the trade by valuing everything  at the beginning and the end of  the  accounting period and by finding the difference may not be  universally applicable  in all cases, and needs  material  modification. The  formula suggested in the Spanish Prospecting  Company’s case(")  was sought to be applied to a case in which  Excess Profits  duty was assessed.  The assessee a  mining  company was unable to work its colliery on account of a strike.  The assessee sought to introduce into its account which normally ended on June 30, 1921, the estimated expenses for repairing the  damage (which though arising in the account period  was restored  later) on the plea that the expenses were  in  the nature  of  liability  of business  and  properly  debitable before  they  were actually incurred.  The  House  of  Lords rejected that contention.  It was in this context that  Lord Buckmaster  observed that the accountancy rules,  applicable to wise and prudent trading could not be used in  connection with the working of a mining lease. These  observations do not affect the true character of  the profits  of a business.  Adjustments may have to be made  in the principle having regard to the special character of  the assets,  the  nature  of the business  and  the  appropriate allowances  permitted,  in order to arrive  at  the  taxable profits.   They do not support the proposition that  in  the case  of  a  trading venture. you can  arrive  at  the  true profits  of a year by ignoring altogether the  valuation  of the  stock-in-trade at the end of the year,  while  debiting its  value at the commencement of the year as  an  outgoing, for  determination of the profits by ignoring the  valuation of  the stock at the end of the year and debiting the  value of the assets at the commencement of the year would not give a true picture of the profit for the year of account. There is no, warrant in this case for assuming that the  Re- venue  authorities and the Tribunal had sought  to  displace the  method  of  accountancy adopted by  the  assessee.   By applying  the  proviso to s. 13, they made  the  computation upon the basis (1) 12  T.C. 1017. (2) [1911] 1 Ch. 92. 789 and in the manner in which in their opinion profits would be properly  deduced.  That they were entitled to do.   We  are therefore  of the view that the High Court was in  error  in holding  that  because  the  assessee  had  maintained   his accounts  in the cash system it was not open to the  Income- tax  Officer  to add to the receipts from the  business  the value  of the stock-in-trade at the end of the year for  the purpose of properly deducing the profits of the business for the year in question. The  appeal therefore must be allowed and the answer to  the question referred to the High Court will be in the  affirma- tive.   The  Commissioner will be entitled to his  costs  in this Court as well as in the High Court. Appeal allowed. 790